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. Last Updated: 07/27/2016

Some Love May Close the Oil and Gas Gap

A bit like a Hilton sister thrown in jail, the Russian oil and gas sector is finally getting some love, or at least some attention, as analysts start predicting a sharp and short-lived comeback for an industry that's hit rock bottom.

As of the start of last week's trading, hydrocarbon stocks were down 18 percent year to date, as high taxes, rising costs and fears of a drop-off in the global oil price have sapped investor confidence.

Since they still represent more than half of the value of the Russian market, energy blue chips have driven a 17 percent wedge between the RTS index (down 3 percent) and the average emerging market (up 14 percent) so far this year.

"The gap has become gaping," said Caius Rapanu, oil and gas analyst at UralSib, and the realization that the biggest stocks are undeniably cheap has led to a market-wide rally.

Gazprom (GAZP) ended the three-day week of trading up 9.4 percent, recovering half the ground it had lost this year. Rosneft (ROSN) gained 3.4 percent for the week, and LUKoil was up 4.1 percent. As a whole, the RTS gained 4.7 percent last week.

A similar jump took place two weeks ago, with the blue chips leading as usual, but was followed by another dour week of trading that shaved 1.7 percent off the RTS.

Last week's rally has a better chance of holding strong, however, as it has become more apparent in recent weeks that second-quarter earnings reports in the oil and gas sector would not disappoint. In March and April, crude export duties were unusually low relative to the global price of crude, which averaged near $63 per barrel in the second quarter of this year.

"When the market starts pricing in those expected earnings, we're going to see a more sustained rally," said Roland Nash, head of research at Renaissance Capital. "The indicators are there, and people are beginning to talk about it. It could happen right now, or it could be as late as July."

Morgan Stanley, which is traditionally more bearish on Russia than most banks, upgraded the Russian market Friday, advising investors to boost its weighting in their portfolios.

Also Friday, the price of crude in New York hit a nine-month high of $68 per barrel, a level which could find short-term support from the U.S. summer driving season, when demand usually peaks, and from repeated promises by OPEC that it will not raise supplies in coming months.

But fundamentally, nothing has changed for the oil and gas firms. They still face a suffocating tax regime and growing cost-side pressure from the need to develop new fields. The expected recovery will therefore be speculative and is not expected to last.

"One bank upgrades, and everybody looks around and says, 'Hey, maybe I should upgrade, too,'" he said. "It's a self-fulfilling prophecy that feeds on itself."

On a one-year time horizon, the story for Russian oil and gas would still be one of underperformance, Nash said. "But sectors focused on infrastructure -- like metals, mining, construction, steel -- they are also cheap compared to [global emerging markets] ... Those are positive trends that could last for years, if not decades."